Regressive Tax - Types and Working with Examples (2024)

Regressive tax implies a system where the tax rate goes down as the taxable income increases. That’s because the tax is levied uniformly regardless of the income. This benefits the high income earners as they have to pay lesser tax whereas the low income earners are taxed at a higher rate..

Let’s understand the types of regressive tax and its workings with examples.

What is Regressive Tax?

A regressive tax is a taxation system where tax is levied on all tax-paying citizens of the country at the same rate, regardless of their income. Thus, all citizens are required to pay the same amount of tax. As the word ‘regressive’ suggests, regressive tax leads to high-income groups paying fewer taxes than their low-income counterparts.

Regressive taxes are not levied on individual income but include sales taxes, property taxes, excise taxes, Government taxes, etc. Regressive taxes are in contrast to progressive taxes, which increase with income. Thus, under the progressive tax system, the higher an individual’s income, the higher the amount of taxes they pay.

Scandinavian countries like Norway, Switzerland, Denmark, Netherlands, and Sweden follow a regressive tax system.

How Does a Regressive Tax System Work?

As mentioned earlier, in a regressive tax system, tax is levied uniformly across all income groups. This severely impacts people who fall into lower income groups compared to people with higher incomes.

It’s often seen as unjust in most cases even if it might be fair in some cases to tax every individual at the same rate. Eventually, most income tax systems are progressive instead of regressive, taxing high-income earners at a higher rate compared to lower-income earners.

Also Read: Progressive Tax: Meaning, Types and Benefits

Types of Regressive Taxes

Listed below are the most popular types of regressive taxes:

1. Sales Tax

The Government applies a regressive tax system for sales tax. The sales tax is levied on the product’s cost or purchase price. It is uniformly applied to all consumers depending on what they purchase. It severely impacts individuals in lower-income groups.

2. Property Tax

Property taxes are partially indexed to income for lower-income earners because they generally live in less expensive homes. Regardless of income, two individuals living in the same tax jurisdiction pay the same property tax if their homes have the same value. They’re not purely regressive as long as they’re based on the property’s value.

3. Government Fees

The Government charges a fee for Government-funded services, identification cards, costs for driver’s licence, toll fees for roads and bridges, etc.

4. Flat Tax

The flat tax refers to a taxation system in which the Government taxes all incomes at the same rate. Furthermore, the flat tax rate system does not allow any credits or deductions. Thus, every individual has to pay tax at a fixed percentage, once again making it challenging for people with lower income.

5. ‘Sin’ Tax

The Government charges ‘sin’ taxes on products it deems harmful to society. These ‘sin’ taxes are added to the original prices of goods, including tobacco and alcohol, to dissuade people from using them.

6. Tariffs

The Government levies tariffs on the import and export of products where the taxes are to be borne by the customers who purchase those products. Due to the necessity of these goods, a high tax rate on imports or exports will burden low-income groups, but they will have no choice but to purchase them because they are necessities.

7. Taxes on Lottery and Gambling

Taxes on lottery and gambling are highly regressive since these are levied at a flat rate regardless of the amount an individual has won in a lottery or while gambling.

Regressive Tax Examples

The regressive tax examples for property tax, taxes on precious items and ornaments, and taxes on lottery and gambling are listed below, respectively:

• Example 1: Consider A and B have an annual income of Rs.1,00,000 and Rs.2,00,000 respectively. They own individual lands with the dimension of 1000 x 1000. They will be liable to pay the same amount of property tax regardless of their income.
• Example 2: Consider the tax on precious metals and ornaments is levied at the rate of 10%. A and B earn an annual income of Rs.1,00,000 and Rs.2,00,000 respectively. They purchased gold of 100gms and 200 gms respectively. They will be liable to pay tax at the rate of 10% on the market value per gram of gold.
• Example 3: Consider A and B wins a lottery amounting to Rs.5,00,000 and Rs.20,000, respectively, while the tax rate is charged at a flat 30%. Here both A and B will be liable to pay the tax on the lottery at the same rate regardless of the amount of money they have made.

Advantages of Regressive Tax

Here are some of the most prominent advantages of regressive tax:

• Regressive tax systems help the Government control the demand for goods that are harmful to the society such as tobacco and alcohol.
• Regressive taxes encourage more investments since high returns on investments will also be charged at a rate similar to lower returns.

Disadvantages of Regressive Tax

Listed below are the primary drawbacks of regressive taxes:

• Individuals in lower income brackets have to spend a significant portion of their incomes as taxes.
• The unemployment rates are likely to increase since people in lower-income groups might be unwilling to work. They will have to give up a major part of their earnings to be paid as tax.
• The Government revenue might decrease if individuals with lower incomes limit their consumption levels.
• Wealthier people will be liable to pay lower amounts in taxes while low-income groups will be liable to pay higher taxes.
• Regressive taxes encourage tax skimming among people with low income.

Difference Between Progressive Tax and Regressive Tax

A progressive and regressive tax can be differentiated based on the following points:

Also Read: What is Tax Incidence and How is it Calculated?

Final Word

A regressive tax is a straightforward tax levied by the Government, regardless of an individual’s income. It is not levied based on the quantum of income; rather, a flat amount is levied for everyone, making it a very convenient form of tax for underdeveloped nations.

However, this type of tax is only suitable for nations where there is little income inequality and where people earn incomes that are comparable to one another, so there won’t be any tax avoidance.

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Disclaimer

This article is solely for educational purposes. Navi doesn't take any responsibility for the information or claims made in the blog.

Read More on Income Tax Act